Dollar-pegged stablecoins backed by adequately secure and liquid collateral can potentially serve as a digital safe haven currency during periods of cryptocurrency market distress, according to a report by two US Federal Reserve Board researchers.
A two-tiered banking system can both support stablecoin issuance and maintain traditional forms of credit creation, according to the report, titled “Stablecoins: Growth Potential and Impact on Banking”.
A narrow bank approach for digital currencies could lead to disintermediation of traditional banking, but may provide the most stable peg to fiat currencies.
The researchers – Gordon Liao, a Harvard University economist researching market frictions, international finance and financial innovations, and John Caramichael, a senior research assistant at the Fed – said stablecoins could serve as a “possible breakthrough innovation” in the future of payments.
In their paper, Liao and Caramichael say stablecoins play a key role in digital markets, and their growth could spur innovations in the broader economy.
Stablecoins are digital currencies that peg their value to an external reference, typically the US dollar.
“In the past year, USD-pegged stablecoins circulating on public blockchains have seen explosive growth, with a combined circulating supply of nearly $130 billion as of September 2021 – a more than 500% increase from one year ago.”
Peg Stability an Issue
The authors note that issues faced by stablecoins include the stability of their pegs, consumer protection, know-your-customer
and anti-money laundering compliance, and the scalability and efficiency of settlements.
“While a range of stablecoin-related issues may be resolved with appropriate institutional safeguards, regulations, and technical advancements, sustained growth in stablecoins in circulation would ultimately impact the traditional banking system in significant ways that are important to understand,” Liao and Caramichael write.
“Our research suggests the broad adoption of asset-backed stablecoins can potentially be supported within a two-tiered, fractional reserve banking system without a negative impact on credit intermediation.”
In such a framework, stablecoin reserves would be held as commercial bank deposits. “We also find that the replacement of physical cash (banknotes) with stablecoins could result in more credit intermediation,” they added.
“[A framework] in which stablecoin issuers are required to back their stablecoins with central bank reserves, minimises the risk of ‘runs’ on stablecoins but can potentially reduce credit intermediation.”
They wrote that a dollar-pegged stablecoins can serve as a “safe haven relative to other crypto-assets during times of market distress if they are perceived to be sufficiently collateralised”.
- George Russell
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